Shortly after grabbing myself some AAPL the other day, I continued deploying my April capital, which includes a fat Q1 bonus from work, into the stock market. As the title of this post indicates, for my next purchase I decided to initiate a position in a company that I personally love and use and that ranks as one of the world’s most admired businesses: American Express. The credit card space is one that I feel tremendously bullish about and one that I’ve been wanting to enter for a while now. On 4/21/2015 I bought 6 shares of AXP at $77.3/share, for a total investment of $463.8.
When deciding whether or not to buy a stock, I perform both a quantitative and qualitative analysis. All the data I use to calculate stuff is pulled from Morningstar. So without further ado, let us first take a look at some of the numbers and ratios behind American Express.
When looking at a company’s revenue growth, I like to compute the compound annual growth rate over 10-year, 5-year, and 3-year periods. This allows me to see whether or not the business has been growing over time and it also shows me whether the growth has been accelerating or decelerating in recent years. Here’s a chart I created of American Express’ CAGR for those 3 time intervals:
As we can see, it seems as though American Express has grown its revenue by a roughly flat 4.5% every year over the past decade, without any acceleration or deceleration. The 5-year CAGR is slightly elevated compared to the 10-year and 3-year CAGRs, but that is easily explained by the fact that the company’s revenue took a dip in 2009 at the peak of the recession, only to bounce back immediately in 2010. As a result, the revenue increase from 2009 to 2010 slightly inflates the 5-year CAGR.
In raw numbers, American Express’ revenue grew from $23.347 billion in 2005 to $34.292 billion in 2014; that’s an increase of roughly 50% over the span of a decade, which is impressive for a financial company that has been around for over 150 years and that suffered a loss in revenue during the Great Recession.
EPS growth is another important metric to look at because it will give you a better picture of a company’s financial health. Revenue growth is nice and dandy, but if net income isn’t increasing proportionally, then there’s clearly something wrong going on. Here’s what American Express’ EPS CAGR looks like:
The EPS growth here seems to agree with the revenue growth we saw in the previous chart; similar 10-year and 3-year CAGRs with an inflated 5-year CAGR, again explained by the dip during the recession. The differences between the 3 CAGRs here are a bit stronger than with the revenue CAGRs for the simple fact that EPS fluctuations during the past 10 years were larger than revenue fluctuations. The company’s EPS dropped from $3.36 in 2007 to $2.33 in 2008 to $1.54 in 2009, whereas the company’s revenue still increased between 2007 and 2008 and only dropped between 2008 and 2009; this explains why the difference between the 10-year and 3-year EPS CAGR is a bit more elevated than the difference between the 10-year and 3-year revenue CAGR. Similarly, the EPS jumped from $1.54 in 2009 to $3.35 in 2010 (more than a 100% increase), whereas revenue only grew from $24.523 billion to $27.819 billion, which explains why the 5-year EPS CAGR is more dramatic than the 5-year revenue CAGR.
Return On Equity
I like to look at a company’s return on equity to get an idea of how much profit it generates with the money that shareholders invest in it. A really low ratio is synonymous with low profitability and begs the question of what the **** the company is doing with our cash. American Express passes with flying colors in this respect: the business boasted an awesome 29.3% in 2014, which completely crushes the industry average of 18.3%. And in 2007, right before the recession hit, the return on equity sat at an even more incredible 37.25%!
One caveat: a really high return on equity can be inflated due to heavy leverage, which is obviously not good. So before rejoicing at the sight of a high return to equity ratio, it’s a good idea to look at a company’s leverage ratios, which brings me to…
The debt-to-equity ratio will tell you if a company has been using a lot of leverage to finance its growth. Acceptable numbers here will vary depending on the industry you’re dealing with; the financials sector in particular is known for having higher debt-to-equity ratios because of the way banks work: they are filthy gypsies who steal your soul they borrow money to lend money.
American Express’ debt-to-equity ratio sat at 2.8 in 2014, just a hair under the industry average of 2.9, which is good.
Interest Coverage Ratio
Another important ratio I like to look at is the interest coverage ratio, which you get by dividing a company’s earnings (before taxes, interest, rainbows, etc.) by its interest expenses. It’s usually nice to see a number above 5 here, preferably even 10, again depending on industry. For some reason, Morningstar doesn’t list any data for American Express here, but according to nasdaq, the interest coverage ratio was 7.74 in 2014, which is solid.
Overall, it seems that American Express is managing its debt decently, and that its fantastic return on equity isn’t the result of high leverage.
American Express’ yield currently hangs around 1.3%, which, while it is low, is still among the meatiest out of all the credit card stock yields out there (Mastercard and Visa both sit around 0.7%).
American Express’ payout ratio is at an extremely low 22%, which means that the company has ample room to grow the dividend over the coming years. This is good news for the yield! #booyeah
Dividend Growth Rate
Dividend growth rate is one of the most important factors to look at as a dividend investor. Here are American Express’ 10-year, 5-year, and 3-year dividend CAGRs:
From the chart, it would seem as though the company has been accelerating its dividend growth over the last 3 years; however, one must take into account the fact that the company froze its dividend from 2008 to 2011 due to the recession, which explains the inflated 3-year CAGR. Nonetheless, a double-digit annual growth rate is fantastic and makes up for the low yield (AXP’s Chowder number ends up above 12, which is acceptable to me).
I used a DDM (Dividend Discount Model) with a discount rate of 10% and a dividend growth rate of 8.5% to valuate the stock. Even though, as we just saw, American Express has had an annualized dividend growth rate in the double digits for the past 10 years, I used 8.5% simply to have a margin of error (I used this same projected dividend growth rate of 8.5% when I valuated Apple). My calculated fair value came out to $89.69, which means that I purchased the stock at a nice discount, and thus wet my panties (errr, not that I wear panties…).
I’m feeling too lazy to write a detailed qualitative analysis for American Express, but who needs one anyway? This company boasts one of the most respected and most valued brands in the world, and it has been around for well over a century. Sure, the recent shenanigans with the loss of its co-brand relationship with Costco might make for some short-term headwinds, but long-term, I only see prosperity for the blue credit card giant.
Like I said in the opening paragraph of this post, the credit card space is one that I’ve been wanting to enter for a while now because I feel very bullish about it. The world’s transactions are increasingly becoming plastic, and that trend is unlikely to stop, ever. However, with the majority of the world’s transactions still being done in cash, credit card companies still have plenty of growth potential, which bodes well for their future and, most importantly, for the future of my pockets as a shareholder 😎
What do you think of AXP? Is it a stock you’d want in your portfolio? How do you feel about the credit card space?
Disclosure: long AXP